Wednesday, October 8, 2008

Ilargi: We are watching the first demise of an entire country today (and I fear for the common people), as Iceland’s last bank fails, and its government cannot make whole -foreign- deposits.

Iceland defaults on its debts. Iceland is bankrupt.

It’s hard to foresee where this will lead, we have little experience with the issue, but there is no doubt that a hard-rain’s-a-gonna-fall among the geysers. Look at what happened to Argentina, where much of the middle class, not long ago, moved into shanty towns while we were busy buying overpriced mansions. Argentina was an exception. Iceland merely is a first.

Iceland will face lawsuits up the wazoo, and it will have to do so broke. Yesterday, it announced a peg for the Kruna to the Euro, and all of a sudden today that’s already gone again. Even Iceland’s own pension funds refuse to help, and choose to leave their assets abroad. Wise move, but.

Because Iceland won’t or can’t repay foreign customers of its banks, countries like England and Holland will now have to compensate their own citizens who took their money out of domestic banks and into Iceland accounts. And if that is not ironic enough for you, how about the fact that these nations just days ago raised the amounts that are government guaranteed? The losses of those who took their money out of the local economy will be paid for by those who didn’t. The poorer (who stay with the corner bank) pay for the losses of the richer. Real cute.

The UK comes with a mind-boggling scheme to prop up the biggest banks in the country. The total amount involved is $876 billion. For comparison: in the US, 5 times as big, that would mean $4.38 trillion. The British government says their idea is much better, since it involves ownership shares, but what are those shares worth when you’re talking about banks that lent out cheap credit that caused home prices to rise 5-fold in 10 years? The survival rate among those banks will be low. And guess who pays for what’s left.

As predicted, the nonsensical global rate cut lifted shares for about half an hour. The reason why this can’t work is really simple. Banks won’t start lending to each other because of a half point rate cut, simply because they didn’t stop that lending on account of a half point. They stopped it because of the casino toilet paper each has in their vaults. And that paper is still there. Until it comes out, there is no solution.

And so, Libor, OIS and TED-spreads, the overnight lending numbers, all go rapidly sky-ward (almost double what they were Monday), and hence none of the cuts seep through to customers or potential home-buyers. The banks need the cash so much, they hoard all they can.

The answer from the central banks is predictable: there will be more rate cuts, it’s all they have left in their tool box, except for martial law, and still nothing positive will happen. It’ll all be sucked up beyond the same old receding event horizon, never to be heard from again. In the meantime, of course, savings accounts will be murdered.

I still can’t understand how anyone at all, after more than two seconds of reflection, could believe that a problem caused by too cheap credit at too low rates could be solved by lowering rates for more cheap credit. I just don’t get the reasoning.

The Bank of Japan was the only major party today not to lower its rates. And that’s because it can’t, it has kept its interest at 0.5% for longer than it can remember. What comes after that, 0%, or even paying people to borrow money? Still, this global rate cut is one more death blow to the yen carry trade, and that happens to have been the biggest source of credit globally. So that cut, and the ones that must inevitably follow, will cut off access to credit, which is the opposite of what it’s supposed to do. Funny world, isn’t it?

In the US, 1 in 6 homeowners are now underwater on their mortgages. And prices are still going down fast, and will go down much more. But what headline did I see today? Pending existing home sales are up 7.4%.... I am so happy to have had the chance to warn our readers away from that lunacy. I ran into a friend, a theoretical physicist, no less, yesterday in Montreal, first time in months, and he came up to me and said I had warned him away from buying real estate last year, and he’s very grateful. Well, that’s why we have a tip jar. The Automatic Earth has saved people millions of dollars so far.

McCain last night was talking about a $300 billion plan to buy up bad loans to stabilize the US housing market. Oh yeah, Mr. Mummy with a dozen homes? What price would you buy at? Want to use taxpayer money to buy hugely overpriced loans, whereas all trends say they’ll fall a lot more? That’s the dumbest thing I’ve heard in a while, and believe me, I’ve heard a few lately. Both candidates proved to be complete disasters in more ways than I can mention, and with no clue of economics. I know you can’t be elected with bad news, but that doesn’t make me a fan of crooks and liars.

Which brings me to the IMF, and its warnings of a global recession this morning. Where the fcuk were you 6 months or even 2 years ago, when an entire chorus of people on the web, from Panzner to Schiff to Supkis to Shedlock, Noland to Bonner to Denninger to Stoneleigh, to, yes, me, were warning, each in our own style and fashion, about what we see before our eyes today? Dr. Doom, me? I don’t think so.

US retirement plans lost $2 trillion, or 20% of their value, in the past year. Coincidentally, that’s about the rate that home prices went down. I have said it so many times: nobody born after 1950 can rely on their pension, retirement, 401k, or whatever it’s called where you happen to live. Please don’t. Please.

The Dow lost 13% in 5 days, the Amsterdam index lost 45% so far in 2008, and trust me, it will keep plunging before there’s a bottom that tries to pose as a ceiling, or the other way around. Get out of there, get out of any instrument that ties you to it.

My thought are with Iceland. Waking up to see your neighbors having gambled away your entire nation, that must be hard.

The cost of borrowing in dollars overnight in London soared for a third day before central banks around the world lowered interest rates in a joint effort to restore confidence to the global financial system.

The London interbank offered rate, or Libor, that banks charge for such loans jumped 144 basis points to 5.38 percent today, the British Bankers' Association said. It was the second day the rate rose more than 100 basis points. The rate was 2 percent on Oct. 3. The one-week dollar rate climbed 35 basis points to 4.52 percent, the highest level since December. The Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record.

"This smells like panic to me," said Marius Daheim, a senior bond strategist in Munich at Bayerische Landesbank, Germany's second-biggest state-owned bank. "We don't think this is going to do the trick with freeing up liquidity in the money markets. Banks will still hoard liquidity to meet future funding needs and rate cuts aren't going to do anything about that."

Interbank lending rates have soared as financial institutions store cash to meet anticipated funding needs, defying the efforts of central banks to revive the frozen credit markets. The Federal Reserve said it cut the target rate for overnight loans by a half point to 1.5 percent today. The central banks of the euro region, the U.K., Canada, Sweden, Switzerland and China also reduced rates.

The overnight euro rate dropped to between 3.8 percent and 4.3 percent after the central banks' announcement, according to Jan Misch, a money-market trader at Landesbank Baden- Wuerttemberg. The rate was fixed at 4.35 percent earlier.Coordinated Action

"The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability," the central banks said in a joint statement. "Some easing of global monetary conditions is therefore warranted." The U.K. said earlier it plans to invest about 50 billion pounds ($87 billion) in an unprecedented step to stave off a collapse of the country's banking system.

The deepening credit crisis forced the U.K. to join the U.S., Ireland, Iceland, Belgium and Spain in rushing out untested bailout measures to save banks. As part of the plan, Prime Minister Gordon Brown's government will buy preference shares, and the Bank of England will make at least 200 billion pounds available for banks to borrow under a so-called special liquidity plan, the Treasury said today in a statement.

The Frankfurt-based ECB said today it provided banks with $70 billion of one-day loans, up from $50 billion yesterday. Banks bid for $122 billion. The 9.5 percent marginal rate at which 96 percent of the funds were borrowed compares with today's Libor of 5.38 percent and the Federal Reserve's target rate of 1.5 percent.

The Libor-OIS spread, which measures the difference between the three-month dollar rate and the overnight indexed swap rate, increased to 324 basis points today. It was at 167 basis points two weeks ago and 81 basis points a month ago. The yield on three-month U.S. bills slid 15 basis points to 0.61 percent, signaling investors still sought the safest government securities. They touched 0.02 percent on Sept. 17, the lowest since the start of World War II.

Libor, set by 16 banks in a daily survey by the British Bankers' Association at about noon in London, determines rates on $360 trillion of financial products worldwide, from home loans to derivatives. Member banks provide estimates on how much it would cost to borrow in 10 currencies for periods ranging from a day to a year. Euribor, set in a survey of more than 30 institutions by the European Banking Federation, is published about 90 minutes earlier.

President George W. Bush signed a $700 billion U.S. bailout bill into law last week to help stem the crisis, which has claimed financial companies including Bear Stearns Cos. and Lehman Brothers Holdings Inc. The legislation enables the government to purchase tainted assets from institutions. European leaders meeting in Paris over the weekend pledged to bail out their own nations' banks, while stopping short of a regional rescue effort.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, was at 391 basis points. Earlier, it widened to 402 basis points, the most since Bloomberg began compiling the data in 1984.Writedowns and losses worldwide tied to the U.S. mortgage market have reached $593 billion since the start of last year, according to data compiled by Bloomberg.

Iceland's fast-moving financial crisis deepened on Wednesday as the government seized control of a large bank it had planned to prop up and the central bank failed to defend the country's currency. Kaupthing , the island's top bank, was forced to take an emergency loan from Sweden and put its Swedish unit up for sale. Its shares dived on the Stockholm stock exchange by 34 percent before they were suspended.

The Icelandic crown, battered in recent days, plunged again and the central bank abandoned its attempt to peg the currency at 131 per euro. It was last trading at 165. "It has become clear that this rate has insufficient support. The bank will therefore make no further attempts in this regard for the time being," the central bank said.

Home to just 300,000 people, the North Atlantic island epitomised the global credit boom that went bust 15 months ago. Its banks expanded dramatically overseas, investors took large positions in its high-yielding currency and foreign firms poured money into local projects. Now facing financial meltdown, Iceland has taken over two of its largest banks -- first Landsbanki on Tuesday and now Glitnir -- and is seeking a 4 billion euros (3.1 billion pounds) loan from Russia.

The financial regulator said in a statement Glitnir's operations in Iceland would be open for business as usual and that domestic deposits were fully guaranteed. Its government was due to send a delegation to Moscow to negotiate terms of a lifeline from Russia, funds the country desperately needs to bolster its foreign exchange reserves. Russian Finance Minister Alexei Kudrin has said Moscow viewed the request positively.

The Swedish central bank said it would lend the Swedish arm of Kaupthing up to 5 billion crowns (402 million pounds) and said the unit had been put up for sale. "The Riksbank has been informed that a process of selling Kaupthing Bank Sverige AB has been started," the central bank said in a document describing the details of its loan. In a growing string of asset sales, Glitnir said it would sell its Swedish unit and its Finnish arm was also up for grabs.

Meanwhile, ING Direct, the online banking arm of ING Group , said it was acquiring more than 3 billion pounds worth of British deposits from Icelandic online savings providers icesave, owned by Landsbanki, and Kaupthing Edge. The Riksbank said it was acting to safeguard Sweden's financial stability -- an indication of how interconnected a small country such as Iceland has become. Riksbank Governor Stefan Ingves told a news conference that the central bank believed Kaupthing was solvent.

Iceland's central bank chief said late on Tuesday the island would emerge in strong shape but he also raised the possibility that the once third-largest bank Glitnir would not survive. "As soon as the ratings firms and foreign lenders realise that we will not indebt the nation, the standing of Iceland will turn around, the currency will strengthen," Central Bank Governor David Oddsson said in a television interview. Kaupthing said it was talking to authorities in Iceland about being involved in a reorganisation of Glitnir.

But Oddsson raised the prospect that the government might not pump money into Glitnir after all. "The state will not inject new capital into the bank unless there is actually a bank," he said. The government stunned markets last week when it announced it would buy up to 75 percent in Glitnir, kicking off what has been a tumultuous 10 days for the small island nation. With asset values around the world plunging, markets fear Iceland could suffer what its prime minister has called a national bankruptcy.

It adopted sweeping powers late on Monday that gave the state the ability to dictate banking operations and allow it to push through mergers or even force a bank to declare bankruptcy. The government swiftly used them to dismiss the board of directors of Landsbanki and put the bank in receivership. As nerves stretched, savers lined up outside a Kaupthing office in Stockholm and Britain threatened action on behalf of more than 50,000 savers with Icesave, which has frozen its accounts.

"We are taking legal action against the Icelandic authorities," Prime Minister Gordon Brown told a news conference, as he announced the UK's own bank bailout. Iceland's social affairs minister, Johanna Sigurdardottir, told local television that the government's housing fund would take over all housing loans held by banks that go under.

Kaupthing’s UK investment bank was placed in administration on Wednesday as the last big Icelandic bank teetered on the verge of collapse. Alistair Darling, the chancellor, placed Kaupthing Singer & Friedlander in administration as the bank attempted to sell assets and loans around the world to stay in business. In a statement, the Treasury said it was taking the action “to protect the retail depositors...[and] ensure the stability of the UK financial system”.

Kaupthing earlier agreed to sell its Kaupthing Edge deposit business to ING, the Dutch bank and had been approached with offers for Singer & Friedlander. The Treasury emphasised that “savers money is safe and secure”. The bank had told the FT on Tuesday that its UK arm was “a superb business, with an excellent franchise and is core to our long-term future”.

The future of Kaupthing looks bleak even though the Icelandic government had said this week that it was a likely survivor of the turmoil gripping the country. While Iceland’s financial regulator has seized control of Landsbanki and Glitnir, Iceland’s central bank has supported their bigger rival with a €500m loan.

As Kaupthing pulled credit from clients in the UK on Wednesday morning, a person close to the bank said: “We are deleveraging very fast now in order to stay liquid.” The knock-on effect from Kaupthing’s rapid withdrawal from international markets has prompted customers such as Robert Tchenguiz to sell equity positions supported by Kaupthing debt.

Founded in 1907, Singer & Friedlander once owned Collins Stewart, the FTSE 250 stockbroker, and it remains an important City institution. It was purchased by Kaupthing in 2005 for £547m. It provides corporate banking, capital markets and investment services. It has 600 employees in the UK and is headquartered in London’s West End with offices in Surrey, Glasgow, Birmingham and the Isle of Man

Kaupthing received funding from Sweden earlier on Wednesday when the Swedish central bank said it was providing up to SK5bn to Kaupthing’s Swedish division to avert “an imminent risk that the bank may suffer liquidity problems”. The decision protects Swedish depositors in Kaupthing’s accounts. ING Direct said it was taking on £2.5bn in deposits from customers at Kaupthing Edge and £538m in savings deposits at Heritable Bank, which is owned by Landsbanki, the Icelandic lender that went into receivership on Tuesday

Britain froze the U.K. assets of Landsbanki Islands hf and threatened to sue Iceland on behalf of 300,000 bank customers who are blocked from accessing deposits through its online savings unit Icesave. "We are taking legal action against the Icelandic authorities," Prime Minister Gordon Brown told journalists at a press conference at 10 Downing Street today. "We are showing by our action that we stand by people who save."

Iceland's biggest banks have racked up foreign debts equivalent to as much as 12 times the size of the economy, compounding investor gloom worldwide following the collapse of firms including Lehman Brothers Inc. U.K. authorities expected Landsbanki to be declared in default, the Treasury said. The assets of Landsbanki, Iceland's second-largest bank, will remain frozen "until the future of the firm and U.K. creditors becomes clearer," the Treasury said in an e-mailed statement.

Icesave's Web site said that it wasn't processing deposits or withdrawal requests for a second day. No one answered the phone at Icesave and an e-mail wasn't immediately returned. The Icelandic government said it wasn't immediately able to comment. Chancellor of the Exchequer Alastair Darling told the British Broadcasting Corporation that the government will guarantee all customer deposits at Icesave, even those above the U.K.'s 50,000 pound ($87,800) deposit protection plan.

"The Icelandic government, believe it or not, have told me yesterday they have no intention of honoring their obligations here," Darling told the BBC.

Landsbanki, which gets 60 percent of its deposits from U.K. and offshore customers, has expanded outside its home market of 300,000 people to diversify its customer base and increase funding from retail deposits. ING Groep NV, the biggest Dutch financial-services firm, agreed today to buy more than 3 billion pounds ($5.24 billion) of retail deposits held by U.K. customers of two Icelandic banks for an undisclosed amount.

The Netherlands said it would contact Icelandic authorities to ensure they fulfill obligations to guarantee deposits at Landsbanki. The Dutch unit of Icesave has 1.7 billion euros ($2.3 billion) in deposits in 125,000 accounts, Dutch Central Bank spokesman Herman Lutke Schipholt said. Luxembourg's financial regulator said it took control of the local unit of Landsbanki. The unit, Landsbanki Luxembourg, requested a suspension of payments, the Commission de Surveillance du Secteur Financier said in a statement. The regulator said it will remain in control until an administrator is named.

Chancellor of the Exchequer Alistair Darling said a 500 billion-pound ($876 billion) rescue package, the biggest in U.K. history, will "go a long way" to prevent the banking system from collapse. "We are beginning the process of un-bunging the markets," Darling told Sky News today. "We want to make sure we can get the system going again. We are stabilizing the system."

The government will provide up to 50 billion pounds to buy shares, and the Bank of England will make at least 200 billion pounds available for banks to borrow under the so-called special liquidity plan. The government will also provide a guarantee of about 250 billion pounds underwrite inter-bank lending.

The partial nationalization of the banking industry will pile pressure on Prime Minister Gordon Brown to show taxpayers will benefit from the measures and to clamp down on excessive pay for bankers. The worsening credit crisis has forced the U.K to join the U.S., Ireland, Iceland, Belgium and Spain in rushing out untested bailout measures to save their largest banks.

Brown hailed the package as a "bold and far-reaching solution" during a period of "extraordinary" financial turmoil. "We could have continued simply to provide liquidity to the market," Brown told reporters at a press conference in London today. "We analyzed this problem in great detail and decided we should go to the root of the problem."

In an interview with BBC radio, Darling said the government is seeking to reduce "the fear factor" that has led banks to all but stop lending to each other. The rescue package will promote longer periods of lending, and help banks rebuild their capital positions, he said.

"The program is designed to build confidence and trust in Britain's banking system and more than that, to put British banking on a sound footing," Brown told reporters. "This is not a time for conventional thinking or outdated dogma." He warned that the government will need to be "satisfied" over the dividends and executive compensation at banks that use public funds, and said he expects the investment to deliver a return to the taxpayer.

At the same press conference, Darling said it would be "ridiculous" for the government to decide on the pay of individuals. Instead, he said, regulators will look at how compensation plans are structured, and whether they give bankers incentives to take too many risks.

The government said it will make 25 billion pounds immediately available in the form of preference shares and stands ready to provide an additional 25 billion pounds. The amount available to each bank will vary and will depend on their dividend payouts, executive pay policies and will require the banks to lend to small businesses and home owners, the government said.

"Unlike in America where basically the bad assets are being taken on by the taxpayer, we're putting money into the system and we'll get it back," Darling told reporters. "The price you'd have to pay otherwise for the wider economy I don't think would be acceptable."

Edinburgh-based Royal Bank of Scotland Group Plc and HBOS Plc, Britain's biggest mortgage lender, surrendered more than half their market value this week as investors lost confidence in their ability to fund themselves. Besides RBS and HBOS, Abbey, Barclays Plc, HSBC Holdings Plc, Lloyds TSB Group Plc, Nationwide Building Society and Standard Chartered Plc are eligible under the U.K. plan. Darling and Brown last night met Bank of England Governor Mervyn King and Financial Services Authority Chairman Adair Turner to discuss the plan.

Desperate to halt chaos swirling through Europe’s markets, , Britain announced a massive, three-part bailout for its banks on Wednesday, pledging hundreds of billions of dollars to restore confidence in the world’s second-largest financial center.

Spain announced a separate, but far less ambitious, rescue package The British authorities sought to shift responsibility for the crisis onto what were depicted as profligate American financial players. “This problem started in America with irresponsible actions and lending by some institutions,” Prime Minister Gordon Brown told a news conference. As a result of the financial crisis, “the global financial market has ceased to function.” He depicted the British measures as more radical than America’s $700 billion bailout.

“We have led the world today with a proposal to restructure our banking system,” Mr. Brown said. “We are taking the steps that I believe other countries will take in the future.” A statement from the British Treasury said at least $350 billion “will be made available to banks under the special liquidity scheme,” doubling the size of a credit line from the Bank of England established as the financial crisis began and designed to unlock frozen lending between banks.

Additionally, the British government pledged $87 billion in direct support for eight major banks. The move amounted to a partial nationalization of some of those institutions. Minutes after the announcement, the FTSE 100 index on the British stock market fell by almost 5 percent, recovering only after central banks led by the Federal Reserve and including the Bank of England announced a coordinated half-percent cut in interest rates.

Mr. Brown said there would be “strings attached and conditions to be met” by the banks. “We expect to be rewarded for the support we provide.” “Our stability and restructuring program is comprehensive, specific and breaks new ground,” Mr. Brown said. “This is not the American plan. Our plan is to buy shares in the banks themselves and therefore we will have a stake in the banks.” “We are not simply giving money,” he said.

Alastair Darling, the chancellor of the Exchequer said the government would continue to do “whatever is necessary” to combat the financial crisis. “The reason we are doing this now is because it is necessary to stabilize the banking system.” The Treasury announcement promised support for the banks in two overall tranches of $43.5 billion to be drawn as preference share capital. The banks were named as Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland and Standard Chartered.

It said the amount to be issued to each of the eight banks remained to be finalized but would take into account issues such as the executive compensation packages offered by British banks and would require “a full commitment to support lending to small businesses and home buyers.” The statement also promised a “ government guarantee of new short- and medium-term debt issuance to assist in refinancing maturing, wholesale funding obligations as they fall due.”

The guarantee _ separate from the independent Bank of England’s credit line _ would be offered for an interim period and on “appropriate commercial terms,” the statement said. “The government expects the take-up of the guarantee to be of the order of” $435 billion, the Treasury said. The initiative came as signs of European economic weakness deepened, and as Iceland, whose troubles are mounting from the global credit crisis, warned that it was working to avoid tumbling into bankruptcy.

Earlier this week, the chief executives of Barclays, Lloyds and Royal Bank of Scotland met with Mr. Darling and pressed him to move quickly to announce a program. “There is no such thing as a safe bank now,” said Willem H. Buiter, a political economist at the London School of Economics. “They are only as safe as the authorities make them.”

In Spain, where a shakeout in the housing market has hit the banking industry hard, Prime Minister José Luis Rodríguez Zapatero announced Tuesday he would create a $41 billion fund to buy assets from the nation’s banks to try to grease the wheels of lending. The fund could be raised to $68 billion and will buy only healthy, not impaired, assets, he said, raising questions about how useful it would be for banks laden with subprime-tainted loans.

At a news conference to reassure the public, he also pledged to raise deposit insurance to 100,000 euros per account. With the credit crisis deepening by the day across Europe, and the shares of major banks continuing to fall on concerns over their solvency, European Union finance ministers Tuesday agreed to temporarily relax accounting rules to help banks avoid fire sales. That move will put European banks and insurers on a level playing field with their American counterparts.

The ministers asked the European Commission, the European Union’s executive arm, to tweak accounting rules that many blame for exaggerating losses on mortgage-linked securities. The rules force banks to book heavy losses immediately because buyers for them are in short supply, even though the expectation is that they will eventually recover much of their value. The Securities and Exchange Commission in the United States made similar changes in September.

"It's not just the hedge-funds, everybody is selling ... And there are no buyers," said Dale Tsang, managing director at Imperial Dragon Asset Management Co. in Hong Kong. "There is a state of panic, for cash. Everybody needs cash." "No, I haven't seen anything like this, and I don't think anybody has seen anything like this before, except those who are over 75 years old and have seen the Great Depression," Tsang added.

Japan's Nikkei 225 Average tumbled the most to close 952.5 points, or 9.4%, lower at 9,203.32 for its worst single-day percentage drop in 21 years. The broader Topix index lost 8% to 899.01. Both benchmarks declined for a fifth straight session. Toyota stock lost 11.6% as shares of exporters were assaulted in the wake of a strengthened yen. The stock was also hurt by a Nikkei business daily report that the company's operating profit in the current financial year ending March 31 is expected to tumble 40% to about 1.3 trillion yen ($12.6 billion) as a deepening financial market turmoil hurts demand for automobiles.

Other exporters also shrank, with Sony tumbling 12.3% and Nintendo plummeting 11.1%. Hong Kong's benchmark index fell below its two-year lows, shrugging off the central bank's decision to cut interest rates by a full percentage point, a move designed to encourage banks to lend more actively to each other.

"I think the basic problem here is of confidence. We don't lack in liquidity, but most banks are keeping the available funds for themselves and not lending to others. That is what is happening everywhere in the world," said Y.K. Chan, strategist at Phillip Capital Management.

The Hang Seng Index finished 8.2% lower at 15,431.73, for its biggest single-day percentage loss since January 22, and its lowest finish June 14, 2006. The Hang Seng China Enterprises Index fell 8.3% to 7,731.68. Every single constituent of both indexes ended in the red. The decline came even after the Hong Kong Monetary Authority Wednesday said it will cut the base rate -- the interest rate at which it lends to banks through its discount window -- by one full percentage point to 2.5% from Thursday, amid "stressful conditions in global financial markets."

"Central banks are applying the right medicine to the credit markets and are in the process of breaking a vicious cycle, but it's not broken yet," said Howard Gorges, vice chairman at South China Brokerages in Hong Kong. "People are waiting for further government action on possible recapitalization of banks."

The losses came after a sell off on Wall Street, as investors found little respite even after the Federal Reserve announced it would buy unsecured commercial paper in an effort to restart a market that has virtually shut down in recent weeks and Fed Chairman Ben Bernanke opened the door for a possible interest-rate cut soon.

In Taipei, the Taiex tumbled 5.8% to 5,206.40, its lowest level since July 2003. China's Shanghai Composite gave up 3% to 2,092.22, while Australia's S&P/ASX 200 fell 5% to 4,388.10, a day after a higher-than-expected one percentage point cut in interest rates by the country's central bank lifted the index 1.7%. South Korea's Kospi lost 5.8% to 1,286.69, New Zealand's NZX 50 index gave up 1.9% to 2,948.31 and Singapore's Straits Times index lost 6.4% to 2,037.84 by late afternoon.

India's Sensitive Index, or Sensex, tumbled 4.3% to 11,203.94, recovering a little after dropping as low as 10,740.76 during the session. Trading in Jakarta was halted for the day after the benchmark JSX Composite fell more than 10%. This is the second time the index dropped more than 10% this week. The benchmark was last down 10.4% at 1,451.67.

Katarina Setiawan, head of research at Kim Eng Securities in Jakarta, said that in addition to the sell off in the U.S. and regional markets, a quarter-point increase in interest rates by the Indonesian central bank on Tuesday "worsened sentiment." "Everybody is selling. Mutual funds are selling their portfolios as well," she said. "But I don't think there will be any further rate hikes, because the central bank also needs to boost the economy."

The Federal Reserve, European Central Bank and four other central banks lowered interest rates in an unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression.

The Fed, ECB, Bank of England, Bank of Canada and Sweden's Riksbank each cut their benchmark rates by half a percentage point. The Bank of Japan, which didn't participate in the move, said it supported the action. Switzerland also took part. Separately, China's central bank lowered its key one-year lending rate by 0.27 percentage point.

Today's decision follows a global meltdown that sent U.S. stock indexes heading for their biggest annual decline since 1937; Japan's benchmark today had the worst drop in two decades. Policy makers are also aiming to unfreeze credit markets after the premium on the three-month London interbank offered rate over the Fed's main rate doubled in two weeks to a record.

"They are throwing the kitchen sink in to try to find stability," said Gregory Miller, chief economist at SunTrust Banks Inc. in Atlanta. "They are clearly trying to get the transmission started again" after a freeze-up of money markets. The Fed reduced its benchmark rate to 1.5 percent. The ECB's main rate is now 3.75 percent; Canada's fell to 2.5 percent; the U.K.'s rate dropped to 4.5 percent; and Sweden's rate declined to 4.25 percent. China cut interest rates for the second time in three weeks, reducing the main rate to 6.93 percent.

"The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability," according to a joint statement by the central banks. "Some easing of global monetary conditions is therefore warranted."

After an initial rally, European shares and U.S. stock indexes headed lower. Some analysts said the central banks should have lowered rates by more, and predicted further reductions. Economists at Goldman Sachs Group Inc. and Morgan Stanley now project another half-point move by the Fed at its Oct. 28-29 meeting.

Futures on the Standard & Poor's 500 Stock Index dropped 3.7 percent at 9:19 a.m. in New York, after plummeting 15 percent in the past five trading days. Europe's Dow Jones Stoxx 600 Index slumped 3.9 percent. Japan's Nikkei 225 Stock Average lost 9.4 percent to 9,203.32 earlier today, before the announcement. "It should have been 1 percent to have a real impact," said Robert Leonardi, a senior lecturer on European Union politics at the London School of Economics.

Global policy makers are reducing rates as economies weaken around the world. The International Monetary Fund said the global economy is heading for a recession in 2009 and increased its estimate of losses from the financial crisis to $1.4 trillion.The Fed's Open Market Committee, which voted unanimously for the move, said in its statement that "incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial-market turmoil is likely to exert additional restraint on spending."

European policy makers were forced into action after the collapse of Lehman Brothers Holdings Inc. last month roiled world financial markets and caught them off guard. The ECB raised rates in July and Bank of England Governor Mervyn King warned the government as recently as Sept. 16 that inflation was set to accelerate. The decision to let Lehman go "had enormous, very unfortunate consequences," Trichet said Oct. 2. On the same day, he said the ECB was ready to cut rates.

Today's action comes a day after Fed Chairman Ben S. Bernanke failed to assuage investors' concerns about the deteriorating economy by signaling he was ready to lower borrowing costs. Fed officials, who have kept their benchmark rate at 2 percent since April, may have wanted time for their record loans to the financial industry and new programs, including purchases of commercial paper, to bear fruit before lowering rates. Investors instead perceive the economic outlook deteriorating more rapidly, necessitating rate reductions.

The declines in U.S. shares the past two days followed pre- market opening announcements of fresh actions by the Fed to unblock credit markets. On Oct. 6, the U.S. central bank doubled its planned auctions of cash to banks to as much as $900 billion. Yesterday, it unveiled a unit to buy commercial paper, debt used by companies for short-term funding.

Central bankers acted two days before they gather with finance ministers from the Group of Seven industrial nations in Washington. The timing suggests the central banks sought to avoid any appearance of being influenced by governments, said Ted Truman, former chief of the Fed's international-finance division.

"It was clear that if they wanted to do it, they had to do it before Friday," said Truman, now a senior fellow at the Peterson Institute for International Economics in Washington. "they don't want to see as being coordinated by their finance ministers into doing this." Bernanke said in a speech yesterday that an intensifying credit crunch means officials must "consider" lowering borrowing costs.

In more typical market conditions, stocks rally when a Fed chief indicates he'll reduce rates. Now, Bernanke's message may have less power because traders already anticipated for weeks that policy makers would need to make that move, and because of rising concern even rate cuts may do little to immediately help banks scrambling to reduce their vulnerability to loan losses.

"In normal times, a rate cut would have a positive effect," Gary Schlossberg, senior economist at Wells Capital Management in San Francisco, said yesterday. "What's troubling the market" is concern about "the solvency and losses of major institutions. The market is uneasy because it doesn't have a lot of information on what the depth of those losses will be."

Interest rates on overnight U.S. commercial paper jumped on Tuesday even after the Federal Reserve unveiled a program to buy this class of short-term debt with the goal to boost this struggling sector, according to Fed data released on Wednesday.

The borrowing costs on these overnight IOU's -- crucial to many companies' ability to raise money for their day-to-day operations -- spiked up 1 percentage point in some cases, the Fed said. On Tuesday, the Fed said it created a facility to buy commercial paper as money market mutual funds, once a major buyer of this type of debt, have shunned it after the bankruptcy of Lehman Brothers shook up the money market fund industry last month.

The Commercial Paper Funding Facility will buy only top-rated or the least risky commercial paper. Of the $1.75 trillion in commercial paper outstanding in August, eligible issuers accounted for $1.3 trillion, but the Fed has no intention to buy anywhere near that amount, government officials said on Tuesday. The Commercial Paper Funding Facility is not up and running yet.

Overnight rates on commercial paper issued by "AA"-rated or mid-investment-grade nonfinancial companies averaged 2.62 percent on Tuesday -- up from 1.39 percent on Monday. The average overnight rate on debt issued by lower-rated nonfinancial companies was 5.67 percent -- up from 4.60 percent on Monday, the Fed said.

The stock market's prolonged tumble has wiped out about $2 trillion in Americans' retirement savings in the past 15 months, a blow that could force workers to stay on the job longer than planned, rein in spending and possibly further stall an economy reliant on consumer dollars, Congress's top budget analyst said yesterday.

For many Americans, pensions and 401(k) plans are their only form of savings. The dwindling of these assets -- about a 20 percent decline overall -- is another setback just as many people are grappling with higher gas and food prices, more credit card debt, declining home values and less access to loans.

"Unlike Wall Street executives, American families don't have a golden parachute to fall back on," said Rep. George Miller (D-Calif.), chairman of the House Committee on Education and Labor. "It's clear that Americans' retirement security may be one of the greatest casualties of this financial crisis."

Even traditional pension plans, which are formally known as defined-benefit plans and are widely considered more stable, have been hit hard by the stock market's volatility, losing 15 percent of their assets over the past year, Peter R. Orszag, director of the Congressional Budget Office, told the House panel.

Despite the losses, companies will still be obligated to pay out the same pensions promised to employees but will have to recoup the extra costs in other ways, Orszag said. "When pension assets decline in 401(k) plans, the burden is on the workers," he said. "When pension plan assets decline in defined-benefit plans, the burden is on the firm to make up the difference. The firm will have to pass those costs on to their workers, to their shareholders or to consumers."

Defined-benefit plans are company-sponsored programs that provide retirement payouts based on an employee's salary and tenure. The company shoulders the bulk of the investment decisions and risk. Defined-contribution plans, such as 401(k)s, turn those tasks over to the worker and are subject to the whims of the stock market.

Increasingly, employers have switched workers into defined-contribution plans. The federal government has also pushed 401(k) plans heavily, approving a law late last year that makes it easier for employers to automatically enroll their employees in them and other similar retirement plans.

Defined-contribution plans tend to be more heavily weighted in stocks, either through individual holdings or mutual funds. As a result, said Orszag, "the value of assets in defined-contribution plans may have declined by slightly more than that of assets in defined-benefit plans." Through September, the percentage loss for the year in average account balances among 401(k) participants was between 7.2 and 11.2 percent, according to the Employee Benefit Research Institute's analysis of more than 2 million plans.

Employees between the ages of 56 and 65 who had the fewest years on the job were the least affected, while those 36 to 45 years old with the longest tenures suffered the steepest declines, said Jack L. VanDerhei, research director for the D.C.-based institute. Younger workers tend to have more stocks in their portfolios while older employees move toward safer investments such as bonds, VanDerhei said.

The findings exacerbate a complaint among many workers and academics about 401(k) and similar plans that are heavily tied to the stock market. Are they really the best retirement vehicles for workers? "The loss of retirement security is a reversal of fortune and the result of very specific flawed governmental policies that have been biased toward 401(k) plans, rather than the result of technological change or the logical consequences of global economic trends," Teresa Ghilarducci, a professor of Economic Policy Analysis at the New School for Social Research, testified before the committee.

Other academics and analysts say 401(k) plans allow employees to take control of their retirements. Jerry Bramlett, president of consulting firm BenefitStreet, said 401(k) participants should resist the urge to pull money out of stocks because that would lock in their losses. "Markets do go up and down, and 401(k) participants must try to remember to think long-term," he said.

Many investors have been buying low-yield Treasury bills in recent months because they are considered less volatile. Bramlett cautioned against that because it would leave them vulnerable to inflation. That said, 401(k) participants should evaluate their portfolios to make sure their money is spread among stock and fixed-income investments. They should also make sure they do not have too much of their own company's stock.

Public pensions also have suffered. The assets held by state and local governments' pension plans declined by more than $300 billion between the second quarter of 2007 and the second quarter of 2008, according to the Federal Reserve. About 60 percent of public pension funds are invested in stocks, 30 percent in domestic fixed-income securities, 5 percent in real estate, and the remaining 5 percent in other products. Miller called the findings "very cataclysmic for middle-class families."

Several analysts who testified at the hearing said the most vulnerable workers are those nearing retirement, who have large balances in their retirement plans that are now shrinking. Tighter household budgets are also crimping workers' retirement savings. According to a survey released yesterday by AARP, 20 percent of baby boomers stopped contributing to their retirement plans in the past year because they have had trouble making ends meet.

Already, more and more workers are delaying retirement, a trend that analysts and economists expect to accelerate because of the distressed economy. The people age 55 and older who work full time grew from about 22 percent in 1990 to nearly 30 percent in 2007, according to the Bureau of Labor Statistics. By 2016, the bureau predicts, the number of workers age 65 and over will soar by more than 80 percent, and they will make up 6.1 percent of the labor force. In 2006, they accounted for 3.6 percent of active workers.

In a surprise move, which reverberated across the international community, Russia issued a four billion euro state loan to Iceland. The statement on Russia’s central bank website reads that the loan maturing in three-four years and an interest rate as low as 30-50 basis points above Libor has been given the green light by prime minister Vladimir Putin.

The news comes as the Icelandic government has been rocked by the gloom of looming state banktuptcy, with its second-largest bank Landsbanki nationalised, and as Russia has opened its state reserves to bail its banking system out, Kremlin itself has received calls for aid from its top four energy giants and seems unable to stop its stock markets’ nosedive.

Russia’s finance ministry originally denied the news. Hours later, however, Russian finance minister Alexei Kudrin admitted Russia had indeed received a loan request, had been reviewing it and had been positive about it because Iceland was a country abiding by strict fiscal discipline. Analysts surveyed by Reuters news agency expressed strong doubts about Russia’s reasoning behind the move and said the loan was the country’s means to restore its reputation as a global factor.

In the meantime, Russia announced it would issue cheap loans worth 950 billion roubles ($36.7 billion) to its ailing state financial institutions. The money will be disbursed within a five-year timeframe and the main beneficiaries will be Russia’s top two banks, Sberbank (500 billion roubles of the total) and Vneshtorgbank (200 billion roubles). The bailout, which comes on top of a $180 billion governmental rescue plan, was a measure agreed at a meeting between the Russian government and the country’s leading bankers.

Russia’s finance minister also spelled intentions to request parliamentary approval to open the state gold and foreign currency reserves to implement a so-called preventive intervention and avert a crisis scenario. In September, the Russian reserves were down $25.6 billion to $556 billion. It arrived at a time when the Russian stock market has been living through record lows, posting the worst losses worldwide and working under intermittent trade.

“Presently, there is nothing rational in Russia’s stock trade,” Uralsib analyst Chris Weafer was quoted by Reuters as saying.On October 7, even Russia’s gas giant Gazprom shed 25 per cent of its market capitalisation and Russian brokerage Troika Dialog estimated that the present market capitalisation of country’s top four public oil companies was tantamount to that of Brazil’s oil company Petrobraz.

Also on October 7, Russia’s top energy companies called on Kremlin to loan-finance them, Bloomberg newswire reported. Oil company LUKoil’s president Vagit Alekperov has been the mastermind of the initiative taken up by his company, Gazprom, Rosneft and TNK-BP and has presented the request to Russian president Dmitry Medvedev. The companies’ executives were said to have received a positive answer.

In the meantime, Gazprom executive Alexander Medvedev urged OPEC, the US and Western European governments to stem the slide of oil prices or else Russian oil companies would suffer a huge blow. Should crude continues to lose value, Russia may cut its oil supplies for the first time in a decade, analysts were quoted by Bloomberg as saying.

We suspect many people in the UK will dismiss Tuesday’s nationalisation of Landsbanki – and the ongoing financial meltdown in Iceland – as someone else’s problem. We’ve got enough to worry about ourselves, people will undoubtedly think.

But thanks to Landsbanki’s Icesave arm, about 300,000 people in the UK will be affected by the bank’s collapse into receivership – and it could well be our tax money that pays them back. We spoke to one of our readers who’s desperately trying to get his savings out of the stricken bank...

Ironically, he only opened the Icesave account earlier this year to try and spread his savings around, to avoid over-exposure to the UK banks. Already a fan of Iceland after visiting the country in January, Icesave’s highly-rated ISA quickly caught his eye when he started looking for an alternative provider. ‘It wasn’t quite the best rate, but it was always near the top of the comparison rankings – and it seemed far more reliable than all of the higher-paying options,’ he said ruefully. Between February and April he opened two ISAs and a savings account, transferring across £17,000 in total.

As rumours about Iceland’s financial trouble mounted on Monday, he went straight to the Icesave website – only to find a statement reassuring investors that Landsbanki was perfectly safe and very different to Glitnir (the Icelandic bank part-nationalised last week). The statement’s since been removed, but we tracked it down online: Iceland, it says, ‘has a strong Government fiscal position with negligible external debt’; it’s ‘driven by internationalisation and a growing financial sector, but otherwise anchored in sectors not affected by the current downturn’ and has ‘enviable long-term prospects’. And unlike Glitnir, Landsbanki's ‘sound business model’, ‘reduced reliance on capital market funding’ and ‘stable recurring revenues’ would stand it in good stead. So much for that...

Our reader was briefly convinced. But when Iceland suspended its stock market, he immediately tried to transfer out £10,000 – he’s now facing an anxious wait to see whether this money will appear in his UK account. As for the £7,000 in his ISAs, the Icesave website is now refusing all withdrawal requests (‘We apologise for any inconvenience this may cause our customers. We hope to provide you with more information shortly’, it says currently). So all he can do for now is try and get the money via a request from an alternative ISA provider.

On Tuesday, it looked as if he (and the other 300,000 UK savers) would have to go through the rigmarole of reclaiming the money from the Icelandic Depositors and Investors Guarantee Fund, which was supposedly responsible for the first £15,000, with the UK authorities picking up the tab for the next £20,000. And he wasn't confident: ‘I don’t see how the Icelandic government will be able to fund a £4bn compensation scheme based on revenues from 300,000 taxpayers,’ he pointed out, not unreasonably.

Sure enough, on Wednesday morning the UK Government revealed that Iceland was refusing to honour its commitments - but fortunately Alistair Darling promised to step into the breach (and also sue Iceland to get the money back). Either way, EU rules dictate that savers should ‘generally’ get their cash back within three months - but chances are it could take much longer.And to add insult to injury, all our reader's UK savings are now with NatWest, a subsidiary of RBS – which of course lost a third of its value on Tuesday. Although our reader still believes RBS is ‘too big to go down’, its recent travails won't inspire any of its customers with a great deal of confidence...

Iceland’s pension funds will not transfer any of their foreign securities back to Iceland as the deteriorating economy is dragging down pension fund assets, IPE has learnt. Hrafn Magnússon, director of the Icelandic Pension Funds Association (IPFA), told IPE: “All discussion with government to transfer 50% of foreign assets from pension funds has been postponed.” He added: “Icelandic pension funds are not going to transfer foreign assets to Iceland – there is no 'fire sale'.”

In an emergency meeting of the board and the reserve board of the Icelandic Pension Funds Association (IPFA) last night, it was resolved an agreement would be postponed as Iceland’s economy was deteriorating further despite the emergency laws enacted by Iceland’s Althingi Parliament. “New information came to light regarding the situation over the course of the weekend, calling for even more widespread and serious reactions on behalf of the government than previously believed necessary,” the IPFA said in a statement last night.

The association has stressed it will encourage the boards and managers of the Icelandic pension funds to meet the needs of borrowers, as much as the situation can allow for at each given point in time. The IPFA has also warned there is likely to be a decrease in pension benefits paid which will come to pass early next year. “The financial situation in markets all over the world and the emergency laws set by the Icelandic parliament will affect the pension funds, as well as all homes and businesses in the country. It is clear that the assets of the pension funds will diminish accordingly,” concluded the organisation.

The news comes as the Central Bank of Sweden has granted Kaupthing, Iceland’s largest bank, a SEK5bn (€514m) loan, to ensure the bank can live up to its commitments towards the customers of Kaupthing’s Swedish branch. Trading in Kaupthing was halted on the Nasdaq-OMX after it shares plunged 34% within the first 30 minutes of morning trading.

The Icelandic Financial Supervisory Authority (FME) took over the board of second largest lender Landsbanki Bank yesterday morning and the government scrapped plans to nationalize Glitnir Bank hf, the country's third-largest lender, putting the company into receivership under the control of the state regulator. In a separate development, the UK government declared this morning it plans to sue Iceland over lost deposits held by thousands of Britons with Icelandic bank accounts.

In its bleakest forecast in years, the International Monetary Fund said on Wednesday the world economy was set for a major downturn with the United States and Europe either in or on the brink of recession. The IMF said a still-developing financial upheaval -- the most violent since the 1930s -- would exact a heavy economic toll as markets wrestle with a crisis of confidence and global credit is choked off.

The IMF's assessment was written before a globally coordinated interest- rate cut of half a percentage point on Wednesday by the Federal Reserve, European Central Bank, Bank of England, Switzerland, Canada and Sweden. China also cut its key rate 27 basis points and its reserve requirements for banks by half a percentage point.

The joint move followed weeks of unprecedented turmoil in global markets that has frozen money markets, even as central banks have pumped billions of dollars into the global financial system. In its report, the IMF warned that credit conditions remain very difficult, restraining global growth prospects. "The world economy is now entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s," the IMF said in its World Economic Outlook.

In hindsight, the IMF said lax economic and regulatory policies probably allowed the global economy to "exceed its speed limit." At the same time, market flaws, together with policy shortcomings, allowed stresses to build. Now, the global economy is about to pay the price.

The IMF slashed its 2009 forecast for world growth to 3 percent, which would be the slowest pace in seven years, from a July projection of 3.9 percent, and warned that a recovery would be unusually slow. It said growth this year would come in at 3.9 percent, a touch below the 4.1 percent it projected in July.

The IMF had believed developing economies could largely steer clear of any painful economic spillover from the credit mess stemming from the deep U.S. housing slump. But no longer. In its latest report, the global economic watchdog warned emerging and developing economies are also slowing, in some cases to rates well below trend.

At the same time, the combination of soaring food and fuel prices has pushed inflation to levels unseen in a decade, the IMF said, exacting an especially heavy toll in the developing world where families' spending on food is high. In advanced economies, oil price increases have also been felt, but underlying price pressures appear to be contained, it added.

The immediate challenge for policy-makers is to stabilize credit markets, while nursing economies through the global downturn and keeping inflation under control, the fund said. It sees the U.S. economy screeching to halt and warned a recession was increasingly likely with gross domestic product likely to contract in the final quarter of this year and the first quarter of 2009. For all of next year, it projects U.S. growth of just 0.1 percent.

"The United States has been at the center of the intensifying global financial storm .. and the economy is now slowing fast," the fund said. The near-term course of the U.S. economy, the IMF said, will largely depend on the effectiveness of recent government initiatives to combat the spreading credit crisis. In Europe, the crisis has stalled growth, and interest-rate cuts and decisive government action to restore confidence to prevent a lasting slowdown are needed, the report said.

The fund said growth in the euro zone is likely to slow to 1.3 percent in 2008 and ease further to a scant 0.2 percent in 2009. Asian powers China and India will also experience slower growth on weaker exports, but should continue to be supported by solid private consumption, it said. Growth in China is likely to come in at 9.7 percent this year and 9.3 percent in 2009 -- compared to 11.9 percent in 2007, the IMF said.

India will grow 7.9 percent this year and slow to 6.9 percent in 2009, it said. The Indian economy grew 9.3 percent last year. Elsewhere in Asia, domestic demand has also softened as high food and fuel prices have weighed on consumption, while declining profit margins and weakening demand have prompted firms to scale back investment plans.

In Africa, the IMF said steady years of growth would be rocked by the financial crisis and higher inflation, although oil producing countries would come off lighter from the economic slowdown.

Discredited and vilified. Those are the words that can begin to describe the people most Americans would term "bankers." Rarely has a broadly defined category of occupation sunk so far, so fast.

Not too long ago, careers in finance beckoned the ambitious and avaricious. In New York, in particular, the only lives worth living seemed to be led by those who worked on Wall Street and whose compensation was determined in widely reported, year-end, life-altering bonuses. That ended, I suspect, shortly after noon on Friday, Oct. 3, when the U.S. House of Representatives passed the $700 billion financial-market rescue plan designed to re-open the nation's credit markets.How long will it take to rehabilitate the profession? Is it three years? Five years? A decade? Fifty years?

The last few weeks have gone by in a blur. And yet it was just the sitzkrieg, the phony war. The real bloodshed will occur in the weeks and months ahead. Nobody knows what the real outcome of this disaster will be, although it's very likely that the financial industry will be crushed. Now the scene shifts to Washington.

This isn't a temporary shift, either, as the U.S. Treasury attempts to pick up the pieces of the financial system. No, I have a feeling that no matter who wins the presidency, we are going to see newly empowered regulators go on the rampage. The taxpayers will demand nothing less. The lords of finance are finished, at least for a while. No longer will these notoriously thin-skinned bully-boys visit their wrath upon those who dared to criticize their doings.

Out: Regulators who can be intimidated.In: U.S. attorneys scrapping for a fight.

Wall Street banks and securities firms maintain lobbyists and associations in Washington to present their case to those who work on Capitol Hill. The almost $1 trillion rescue plan renders these folk nullities. Can they speak with any authority, even any credibility? I'm not saying this is necessarily a good thing. Yet this seems to be the consequence of almost bankrupting the country. Finance surrendered.

Mutiny in Congress and the gyrations of the Dow Jones Industrial Average have overshadowed the municipal-bond market. That is, until Governor Arnold Schwarzenegger of California sent an e-mail to Treasury Secretary Henry Paulson on Oct. 2, saying the state might have to turn to the federal government for a little loan of $7 billion.

The municipal-bond market had almost shut down by the time the governor sent his e-mail, dozens of issuers shelving their borrowing plans upon the advice of their underwriters. For several years the government has been looking at the municipal market, in particular at how states and municipalities invested the proceeds they raised from bond issues. I hope the big bailout doesn't distract them because if a market richly deserved some scrutiny, it is this one.

I almost don't know where to begin, but how about with Moody's Investors Service lowering the credit rating on the Massachusetts Turnpike Authority Metropolitan Highway System? On Oct. 2, the rating company put out a press release stating that the "key reasons for the downgrade are narrowing debt service coverage ratios due to escalating debt service and increased interest costs associated with exercised swaptions," and you can stop right there.

Swaptions! Interest-rate swaps and derivatives! From coast to coast, these things are eating issuers alive. I'm not sure I'm angrier at the bankers who so aggressively pitched the things, the politicians who bought into them because they could get campaign contributions from the brokers who set them up, or the bond-rating companies that rarely delved into the risky nature of these products in their regular analyses.

The full effect of the financial crisis is still murky. We do know that state and local tax revenue is declining, and that the business environment is turning sour. A bumper crop of municipal-bond defaults seems likely. How fitting it is that they will be coming even as the rating companies cave in to issuers' insistence that they all deserve upgrades to AAA.

As for the bankers, they admitted the ignorance of their actions by going to Washington and asking for a bailout. They didn't understand some of these layers upon layers of securities they had created. They didn't surrender, so much as abdicate. It will be some time before anyone listens to their like again.

Investors looking for safe haven from the global economic storm are flocking to the yen, but that's raising fears of a long-term slowdown in Japan, the world's second-largest economy. The dollar fell below 100 yen for the first time since April during trading in Tokyo. Later on Wednesday, the dollar was at 100.58 yen.

The yen is attractive compared with other major currencies because Japan, with its relatively stable banking system, is widely seen as a refuge during periods of global economic upheaval. But a stronger yen creates a host of problems for Japan's export-driven economy. It makes Japanese-made products like cars and televisions more expensive in overseas markets and thus less competitive. It also means that the value of Japanese companies' overseas earnings are diminished when converted back into yen, hurting the health of the overall economy.

Toyota Motor Corp., for example, which makes 74% of its sales outside Japan, is particularly vulnerable to the yen's climb. Every time the dollar's value slips by one yen, Toyota sees its annual operating profit cut by 40 billion yen, or about $400 million. For the fiscal year ending March 2009, the Japanese auto maker had assumed a dollar exchange rate of 105 yen. Combined with a slump in auto sales in the U.S. and other markets, a stronger yen presents severe headwinds for the company. "It's tough. We really feel it," said Yoichiro Ichimaru, one of Toyota's senior managing directors.

Exporters were among the hardest hit on Wednesday, amid a sharp drop in shares across Asia. The Nikkei 225 Stock Average closed at 9,203.32, down 9.4%. Fearing that a further strengthening of the yen in the weeks ahead would erode their profits, Japanese exporters have also stepped up selling dollars and euros for the yen to repatriate money, further strengthening the yen.

Osamu Takashima, an analyst at Bank of Tokyo-Mitsubishi UFJ, said the yen is likely to stay on an upturn against the dollar in the long term as demand for financial assets in the U.S., with its growing trade and fiscal deficits, will shrink. Shoichi Nakagawa, Japan's finance minister, on Wednesday characterized recent foreign-exchange moves as not so volatile, suggesting Tokyo isn't planning on propping up the greenback in the foreseeable future. But he said he will closely watch global stock markets.

The yen's climb against other currencies is aided by Japanese individuals who trade currencies through online brokers, often using high leverages. Many of these investors have been reducing their foreign currency positions and converting the money back into the yen as other currencies tumbled against the yen.

At Money Partners Co., one of the larger online brokers, customers buying back the yen has been surpassing those buying foreign currencies this week. Trading volume shot up by over 50% in September from August and has continued to be very high since the beginning of this month, said Naohiro Sato, director in charge of corporate planning at Money Partners. "When it looks as though the economies from around the world were melting down, people are buying back the yen as the least of all evils."

The yen surged, breaching 100 per dollar for the first time in six months, after a plunge in global stocks prompted investors to reduce holdings of higher- yielding assets funded in Japan.

Foreign-exchange volatility implied by dollar-yen options rose to the highest in almost a decade amid concern the credit crisis will deepen. Currencies including the South African rand, Korean won and Mexican peso sank more than 6.5 percent against the yen as investors pulled out of emerging-market assets.

"The only thing to do is to buy yen," said Steve Barrow, a currency strategist at Standard Bank Plc in London. "There are long-term investors with positions funded out of the yen that are completely capitulating." Japan's currency rose to 99.22 per dollar at 11:15 a.m. in London, from 101.47 yesterday in New York. It reached 98.61 earlier. The yen also climbed to 135.07 against the euro, from 137.89, and reached 134.17. The dollar was at $1.3614 per euro, from $1.3588 yesterday.

The yen advanced as the cost of borrowing on Asian money markets increased, reflecting the reluctance among banks to lend on speculation more financial institutions will fail. Hong Kong's three-month interbank offered rate, or Hibor, rose 29 basis points to 4.15 percent, even as Hong Kong slashed the rate at which it lends to banks.

Shares worldwide tumbled, extending a global sell-off that's erased more than $5 trillion of market value in the past week. The world economy is headed for a recession next year, with U.S. growth forecast at 0.1 percent, according to International Monetary Fund reports published this week. The MSCI World Index lost 2.7 percent, falling for a fifth day.

"The rally in the yen is reflecting the fear and paranoia that is being kicked around the markets," said Jeremy Stretch, senior strategist in London at Rabobank International. "Investors continue to retreat and shelter as much as they can in the traditional safe haven of the yen."

The rout in stocks battered the so-called carry trade, in which investors get funds in nations such as Japan that have low borrowing costs and buy assets where returns are higher. The Australian dollar fell to its lowest level in more than five years against the yen, trading at 66.29 cents, from 71.63 yesterday. The won slumped to the lowest in almost a decade against the dollar, to 1,395 from 1328. Benchmark interest rates are 0.5 percent in Japan, 4.25 percent in Europe, 5 percent in the U.K., 6 percent in Australia and 7.5 percent in New Zealand. The risk of a carry trade is that currency moves wipe out profits.

Implied volatility on one-month dollar-yen options soared to 25.56 percent, the highest since October 1998, from 21.79 percent yesterday. Implied volatility on one-month euro-dollar options was at its highest since the single currency's debut at 19.85 percent. Higher volatility may discourage carry trades as it indicates a larger risk of price fluctuations.

The dollar may extend declines against Japan's currency amid Federal Reserve signals that it's prepared to lower interest rates, narrowing the difference in benchmark rates between the two economies. Philadelphia Fed President Charles Plosser speaks on monetary policy at 7:45 a.m. in New York today. The Fed "will need to consider whether the current stance of policy remains appropriate," Chairman Ben S. Bernanke said yesterday. The U.S. central bank said yesterday it will set up a special vehicle to buy commercial paper and help revive the corporate-debt market.

"The dollar is likely to edge lower," said Tsutomu Soma, a bond and currency dealer in Tokyo at Okasan Securities Co., Japan's fifth-largest broker by revenue. "A possible Fed rate cut highlights how dire the situation is in the U.S. The fundamentals simply aren't sound."

Futures on the Chicago Board of Trade showed yesterday a 64 percent chance the Fed will lower its 2 percent target lending rate by a three-quarters of a percentage point at its Oct. 29 policy meeting. The odds were 32 percent yesterday. The pound climbed a second day against the dollar after the U.K. Treasury said it will invest $87 billion in the country's banking system. The government will buy preference shares in British banks and the Bank of England will make at least 200 billion pounds available for borrowing. The Treasury will also provide a guarantee of about 250 billion pounds to help refinance debt.

The Bank of England will reduce its 5 percent benchmark rate by a quarter-percentage point tomorrow to revive the economy, according to the median forecast of economists surveyed by Bloomberg News. The London-based National Institute for Economic and Social Research said today policy makers should enact a half-percentage point reduction.

Finance ministers and central bankers from the Group of Seven nations will meet in Washington Oct. 10 to discuss the deepening financial crisis. Measures to stabilize global stock markets will be on the agenda, according to a Japanese official who briefed reporters on condition of anonymity. Joint action on currencies and interest rates should depend on economic conditions in member countries, the official said. The G-7 is comprised of Canada, France, Germany, Italy, Japan, the U.K. and the U.S.UBS AG recommends investors buy the dollar at 102.40 yen, with a target of 107, as governments work to restore confidence in the global financial system.

"The market has reasons to respond positively to efforts from officials in Europe and the U.S.," wrote analysts led by Benedikt Germanier, a Stamford, Connecticut-based currency strategist at UBS, in a research note yesterday. "Efforts may soon reach a critical level in our view, helping investors' sentiment."

The yen also may gain as Japanese investors repatriate funds to cover for potential losses before the fiscal year ends in March, said Tomoko Fujii, Tokyo-based head of economics and strategy at Bank of America Corp. "There's still an upside risk to the yen," Fujii said, confirming a research note dated yesterday. "Japanese financial institutions are not very profitable. Domestic equities are weak, which means no valuation gain cushion. In that case, there could be serious repatriation pressure."

When Wells Fargo & Co.'s John Stumpf was promoted to chief executive officer last year, he said a big East Coast acquisition was "highly, highly unlikely." Back then, Wachovia Corp. was selling for more than $50 a share.

Now, with Wachovia's stock down 90 percent, the appeal of more than doubling the San Francisco-based bank's deposit base is too much to resist, even with the potential for $74 billion in mortgage losses, said Wells Fargo Chairman Richard Kovacevich. "There will be some hard work needed to work through these asset problems," said Kovacevich, 64, who still handles strategic tasks after ceding the CEO title to Stumpf, in an interview last week. "The opportunities the franchise brings to us over time more than compensates for those losses."

Wells Fargo must first defeat Citigroup Inc., which went to court after its original $2.16 billion bid for Wachovia's banking operations was trumped four days later by Wells Fargo's $15 billion offer for the whole company. Each is vying for Wachovia's $448 billion in deposits, an increasingly valuable resource as lenders scrounge for way to replace capital depleted by $593 billion of losses tied to the global credit crunch.

"It's a risk worth taking," for Wells Fargo, said Bart Narter, head of the banking group at Celent, a San Francisco- based research firm. "The plus side of it is a nearly perfect complement to their existing branch network." With Wachovia, Wells Fargo would become the biggest U.S. bank by number of retail locations. It would have 6,675 branches, compared with Bank of America Corp.'s 6,100. More than 40 percent of Wachovia's branches are in Florida, North Carolina, New York and New Jersey, according to data from Celent, while over half of Wells Fargo's are in California, Texas and Arizona.

The three banks called a two-day halt to legal wrangling over Wachovia on Oct. 6 while they try to work out a compromise. The truce may end at noon New York time today. Wachovia is bracing itself for a deal that may have Wells Fargo buy the bank and then sell parts to Citigroup, two people briefed on the negotiations said yesterday. Citigroup would get branches in the Northeast and about a quarter of Wachovia's deposits, and Wells Fargo would take the branches in the South and Mid-Atlantic states, said one of the people, who declined to be identified because talks are private.

Sung Won Sohn, a former chief economist at Wells Fargo, said bank officials had discussed the possibility of teaming up with Wachovia for years. Sohn started working as an economist at Wells Fargo's predecessor company, Northwest Bancorp, later Norwest Corp., in 1974, and left the bank in 2004 to become CEO of Hanmi Financial Corp. in Los Angeles. He retired last year.

"I knew someday we had to become a national franchise and we thought Wachovia was a very good fit because it was a very well-run bank at the time," said Sohn, now a professor of economics and finance at California State University Channel Islands. Wachovia added 1 cent to $5.26 a share at 10:43 a.m. in New York Stock Exchange composite trading. Citigroup slid 4.2 percent to $14.51, while Wells Fargo advanced 5 percent to $30.60.

On the East Coast, Wells Fargo is an unknown, compared with Bank of America, Citigroup and JPMorgan Chase & Co. Should Wells Fargo succeed in acquiring all of Wachovia, it would gain more than 3,300 branches and boost its deposit base beyond $700 billion. JPMorgan, based in New York, became the biggest U.S. bank by deposits with about $900 billion after last month's purchase of Washington Mutual Inc.'s branches, located mostly on the West Coast and in Texas and Florida.

Unlike Citigroup, which planned to buy only Wachovia's branch operations, Wells Fargo's agreement included the $498 billion loan portfolio with about $122 billion in option adjustable-rate mortgages. Record foreclosures led to an $8.9 billion second-quarter loss at Wachovia. Citigroup, whose predecessors employed Kovacevich from 1975 to 1986, said this week that it was set to officially announce its Wachovia deal on the morning of Oct. 3, had Wells Fargo not intervened earlier that day.

As the two sides negotiate with the help of U.S. regulators, a division of Wachovia's assets may be on the table, analysts have said. Nancy Bush, analyst at NAB Research LLC in Annandale, New Jersey, said Wells Fargo may not accept a split."Everyone is waiting on the edge of their seats for this to be resolved," she said. "Knowing Dick Kovacevich, I'm sure he's got his heels dug in."

Kovacevich was chief operating officer at Minneapolis-based Norwest in the 1980's when Stumpf, 55, was running the auto- dealer business and working on commercial loans. Kovacevich was promoted to CEO of Norwest in 1993. Norwest bought Wells Fargo in 1998 for $32.3 billion, moved to San Francisco and kept the Wells Fargo name.

As head of Texas operations from 1994 to 1998, Stumpf led the acquisition of 30 banks. He climbed to COO in 2005 and, since replacing Kovacevich as CEO in June 2007, has orchestrated at least 11 acquisitions to bolster the company's insurance business and pick up deposits in states including Colorado and Texas. "I bet John has been personally involved in 80 or 90 deals," Kovacevich said. "This is bigger but really the process you go through is actually quite similar."

The relentless slide in home prices has left nearly one in six U.S. homeowners owing more on a mortgage than the home is worth, raising the possibility of a rise in defaults -- the very misfortune that touched off the credit crisis last year.The result of homeowners being "under water" is more pressure on an economy that is already in a downturn. No longer having equity in their homes makes people feel less rich and thus less inclined to shop at the mall.

And having more homeowners under water is likely to mean more eventual foreclosures, because it is hard for borrowers in financial trouble to refinance or sell their homes and pay off their mortgage if their debt exceeds the home's value. A foreclosed home, in turn, tends to lower the value of other homes in its neighborhood.

About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth, according to Moody's Economy.com.The comparable figures were roughly 4% under water in 2006 and 6% last year, says the firm's chief economist, Mark Zandi, who adds that "it is very possible that there will ultimately be more homeowners under water in this period than any time in our history."

Among people who bought within the past five years, it's worse: 29% are under water on their mortgages, according to an estimate by real-estate Web site Zillow.com. The majority of homeowners still have equity, and even among those who don't, many continue to make their mortgage payments on time. The financial-bailout legislation could at least "keep things from getting much worse" by helping banks avoid the need to tighten credit further, says Celia Chen, director of housing economics at Economy.com.

Still, she expects housing credit to remain tight and home prices to decline in much of the country for another year or so. Prices are back to 2003 levels in the San Diego and Boston metropolitan areas, and back to 2004 levels in Las Vegas, Los Angeles, San Francisco, Fort Lauderdale, Fla., and Minneapolis, according to First American CoreLogic, a data firm in Santa Ana, Calif.

Stephanie and Jason Kirschenman thought they were being prudent when they agreed in late 2004 to buy a new four-bedroom home in Lodi, Calif., for $458,000. They put a substantial 20% down and chose a loan with a fixed interest rate for the first 10 years. Two years later, they took out a second mortgage to pay off some bills. At the time, the home was appraised for about $550,000. But a mortgage broker recently estimated its value at well below the $380,000 the family owes on it, says Ms. Kirschenman. "We were quite shocked," she says.

The Kirschenmans, who both work for a company that makes trailer hitches, thought about sending the keys to the lender. But their financial planner, Christopher Olsen, helped persuade them to stick with the house, noting that they could still afford the payments. Others aren't so lucky. Among mortgages on one- to four-family homes, 9.16% were a month or more overdue or were in foreclosure in the second quarter, according to the Mortgage Bankers Association. That compared with 6.52% a year before and was the highest level since the association began such surveys 39 years ago.

Falling values have contributed to a sharp pullback in mortgage lending. In the third quarter, mortgage lending fell to the lowest level in eight years -- down 44% in a year -- says the publication Inside Mortgage Finance. One reason is that as home values slip, growing numbers of would-be borrowers lack sufficient equity to refinance. The falling values also make mortgage lending look riskier to banks, spurring them to tighten credit standards.

Most mortgages in default were issued in 2006 and 2007, when lending standards were loosest and the housing market was peaking. Many who bought then made small down payments or none, so they had little equity in their homes from the start.The performance of loans made earlier is getting worse, too, as price declines deplete the equity people built up. In Las Vegas, 6% of home loans made in 2004 are now 30 days or more overdue, up from 3.7% a year earlier, according to research firm LPS Applied Analytics.

In July, Congress enacted legislation designed to help borrowers who owe more than their homes are worth by allowing them to refinance into a government-backed loan, provided their mortgage company forgives part of their principal. It's not clear how many borrowers the program will help, because before reducing the principal, lenders would almost always try first to freeze or reduce borrowers' interest rate to make payments more affordable, says Tom Deutsch, deputy executive director of the American Securitization Forum, an industry group.

In contrast with the 12 million home borrowers estimated to be under water, 64 million have equity in their homes. These include 24 million households who own their homes free and clear, and 40 million whose homes remain worth more than is owed on them.

Even so, some borrowers fret that declining prices and tighter lending standards could make it hard for them to tap their equity.Steven Schneider, a mortgage broker in Miami, bought his home at the end of 1992. When he refinanced about four years ago, he pulled out $150,000 in cash that he intended to use to build an addition. The transaction raised his total debt to about $350,000, at a time when his home had a value of about $650,000.

Recently, Mr. Schneider pulled out roughly $90,000 by tapping a home-equity line of credit. He says he put the funds in a money-market account that yields less than the 5% interest rate on the loan. "I was afraid they were going to shut down" access to the credit line, says Mr. Schneider. He figures his home, once valued at $750,000, now is worth about $600,000.How much pain homeowners feel varies greatly from place to place. The most severe drops in home values are in parts of California, Florida, Nevada, Arizona and other areas where speculation pushed prices up and builders far overestimated demand.

Within metro areas, neighborhoods with short commutes are holding up better than others. And in many parts of Texas and North Carolina, home prices have continued to rise slowly, have leveled off or have declined only modestly. On a national basis, home prices peaked in mid-2006 after rising 86% since January 2000, according to the First American index. Since peaking, that index has fallen 13%.

The declines have made homes more affordable, bringing prices in many areas closer to their long-term relationship to incomes. In the second quarter, the median home price of about $203,000 was 1.9 times average pretax household income, according to Economy.com. That was close to 1.87 times income for 1985 through 2000, prior to the housing boom.

Housing markets don't tend to turn around quickly. The price slump in California in the early 1990s, for instance, was a long grind. According to the S&P/Case-Shiller home-price indexes, Los Angeles prices peaked in June 1990 and didn't bottom until March 1996. They didn't get back to their 1990 peak until 2000.

Economists say Canada is headed for one of the toughest financial periods in recent memory, as job losses climb and energy prices tumble, but it's hard to tell just how bad it might get over the next year and a half. Making it hard to predict, says TD Bank chief economist Don Drummond, is that the current economic crisis hasn't followed historical trends so far.

"The starting point doesn't have any comparisons, that's the difficulty," he said on Tuesday. "You try to find a similar period in history and look at the conditions that will match that. But what do you do when you've never been here in history?"Drummond says today's trouble is unlike the Great Depression, the Japanese banking problems of the 1990s or any other major periods of stock market turmoil. Which isn't to say that economists are shying away from making dire forecasts.

Canadian Auto Workers economist Jim Stanford is betting on the darker side of things, predicting that Canada will be in a full-blown recession by the end of this year. He bases his pessimistic outlook on plummeting oil prices, which have descended from a record-high above US$150 a barrel to below US$90 on Tuesday. "Our economy has been very reliant over the last five years on the commodities bubble," he said.

"If anything, the downturn in Canada could be worse because on top of the financial uncertainty, we had invested so many eggs in the resource basket. Now that the commodity bubble has popped, we're going to feel that pain on top of the general financial uncertainty that everyone is grappling with." Furthermore, the manufacturing sector in Central Canada is going to wallow in its existing problems for several years and will likely see more job cuts – up to another 100,000 – within the next year, Stanford predicted.

"Our manufacturing sector has been decimated and many of those jobs aren't coming back," he said. And the longer the turmoil goes on, the more serious the hit will be to consumer confidence, suggested Doug Porter, chief economist at the Bank of Montreal. "If you begin to get further weakness in employment that's what's really going to weigh in on consumer spending," he said. "To some extent, the Canadian consumer has led a charmed life over the last few years between low interest rates, strong job growth and the falling price for a lot of big ticket items."

"It's tough to build a bullish case at this point." The shift in overall economic sentiment is a far cry from where economists were a year ago, when they expressed confidence that the U.S. subprime mortgage debacle's influence on credit markets was easing and wouldn't bleed into the Canadian economy. Last October, the Conference Board of Canada predicted that the U.S. housing crisis would stretch at least into the autumn of 2008, but that neither the U.S. nor Canada would be slammed by a recession.

CIBC World Markets economists said the stock markets were showing signs that credit troubles were easing, while TD Bank expected the loonie to hold near parity well into this year. Instead, markets are still being punished by the rippling effects of the credit crisis, and the loonie was sliding below parity with the U.S. dollar within weeks of the TD economist's prediction.

Drummond was part of the group that put their bets on a stronger dollar, and he said that with the rash gyrations in markets and commodities, it has been tough to find an estimate and hold to it. "You go out with a weak baseline case, acknowledge to people very honestly that there's an extraordinary amount of uncertainty and you have to be prepared for the possibility of it being quite a bit worse," he said.

In a desperate bid to help U.S. banks recapitalize, Washington is dropping its inhibitions and reaching out to Canadian financial institutions to gauge their willingness to participate in rescue operations. The Federal Reserve has activated a back channel that puts the central bank in direct contact with chief executives at Canada's largest banks and insurers, according to a person familiar with the dialogue.

They are approaching "banks with major assets in the U.S. like [Toronto-Dominion Bank] and Royal [Bank of Canada], because when they have a bailout situation they want everyone who is a potential buyer to look at it," the source said. The ongoing conversations between the U.S. central bank and Canadian executives reflects the challenge facing Washington as it seeks to address both short-term liquidity and permanent capital needs of financial institutions crippled by more than $500-billion in losses and limited access to financing.

The communications have included phone calls from Fed officials pitching potential sales of assets of U.S. financial companies and at least one intensive discussion of a major rescue operation, according to people familiar with the contacts. The Fed has been steadily widening the circle of foreign institutions it is working with as the banking crisis has deepened, according to a former Fed official now on Wall Street.

The outreach to Canadian companies signals a more permissive environment in which U.S. authorities would look very favourably on an intervention by a Toronto-based institution. It comes as Washington deploys greater reserves than initially anticipated to restore liquidity, while still facing an uphill battle to help banks recapitalize at a point in the crisis when projected losses of up to $1-trillion still ahead for the global banking system.

The engagement of Canadian institutions follows U.S. federal assent for the acquisition of assets in bankrupt Lehman Brothers by the U.K.'s Barclays, in a deal that followed intensive discussions with the Federal Reserve and U.S. Treasury. That deal was smoothed by good relations between the London and Washington and a lower level of resistance to a deal with the U.K. on Capitol Hill, where political disquiet over foreign interventions has helped keep some buyers at bay. "Canada is not China," said a former Fed official.

A lobbyist for a Canadian bank said the political climate in Washington had changed markedly since the passage of a $700-billion bailout and that this country is now seen as a potential source of support. Executives and advisors in the Canadian financial services industry indicated they still saw live opportunities for their sector to help drive consolidation and recapitalization in the U.S., despite limited flexibility at a time when sinking markets were lowering all boats.

"I don't think Canadian banks want to take a lot of balance sheet risk but I don't think they are going to have to," the source said, adding that while the target banks have many subprime mortgages, the Federal Reserve will backstop these high-risk liabilities. "We could end up in a funny situation two years from now saying this was a once in a generational opportunity for Canadian banks."

U.S. regional banks remain in deep distress and an acquisition of this scale is seen as possible in the coming months, as Canadian banks cautiously explore possible buys and after TD Bank Financial Group put its name forward during an auction of Washington Mutual. A broad sell-off in the U.S. insurance sector has also cut into the valuations and capital positions of U.S. insurers seen as possible matches for Sun Life and Manulife, the Canadian life insurers.

Sun is actively weighing the likelihood of an intervention in the U.S., according to one person in the industry. A foreign bank executive who participated in a recent round of rescue talks with the Fed said U.S. authorities were also keeping national regulators informed of high-stakes negotiations. It was not clear how deeply involved Canadian authorities were in the discussions.

Last year, the basic price of shipping a large container of goods from Asia to Europe, the world's busiest route, was $2,800. This week, with demand plunging amid a worsening economy, that price was an unprofitable $700. That rate is "unsustainable," says Eivind Kolding, chief executive of Copenhagen-based A.P. Moller Maersk AS, the world's biggest shipping company by sales. The industry would be crippled if that price doesn't rise soon, he says.

Hit by the global economic downturn and a financial meltdown that promises an even sharper drop in once-hot trade flows, container-shipping companies are cutting routes and capacity to stem a sudden flow of red ink. Making their plight worse, the container shippers during boom times ordered fleets of new vessels for as much as $50 million apiece that are getting delivered only now -- just as business dries up. Analysts say companies likely will try to cancel their orders, sell the ships, or even convert them to tankers or cruise vessels.

The plight of the $150 billion container-shipping industry shows how the credit crunch and global downturn have caught up to companies that make investment decisions years in advance. Other shipping routes, including Asia-U.S. lanes, also are suffering from declining demand. But the U.S. has tighter harbor space than Europe. Prices for the smaller ships docking in California, Texas and the East Coast have settled around a barely profitable $1,500 a container, analysts say.

The past 10 years were a gold rush for shippers. China joined the World Trade Organization and sold hundreds of billions of dollar of goods to European and American consumers, who were enjoying low interest rates and steady economic growth. Factories relocated to Asia, stretching supply chains around the globe. Oil was cheap, ships were relatively scarce and shipping prices soared.

Container-shipping traffic on the Asia-Europe route rose at roughly 15% a year through the period. This year it will increase just 5%, says Philip Damas, of London-based maritime consultant Drewry Shipping Consultants Ltd. Capacity is growing much faster. "There's a glut of new large container ships entering the market," Mr. Damas says. Freight-shipping prices are notoriously volatile, depending on weather, ever-changing capacity and shifting trade flows. But the recent slide is unprecedented, analysts and shipping-company executives say.

Maersk, the world's No. 1 shipper with sales of $51.2 billion last year, waited until Thursday to cut container rates to their present low. Mr. Kolding, the Maersk CEO, told trade publication Lloyd's List that he hadn't seen the collapse coming. He promised "changes" later this month. That means running fewer vessels in a bid to run up prices, and maybe dropping an Asia-Europe route, a Maersk official said.

Rates for ships heading from Europe to Asia are even more depressed than the reverse trip -- about $200 per 40-foot container. These days, 60% of containers making that trip are empty, reflecting Europe's trade deficit with China, which stood at $223 billion last year. Zim Integrated Shipping Services Ltd. on Saturday canceled its new Asia-Europe route, which it started in January with nine ships. Zim, based in Haifa, Israel, says it is betting that rates will pick up in time for the arrival late next year of two mammoth container ships being built.

Eager to cash in on the trade boom, companies such as Zim a few years ago put in a wave of orders to South Korean and Chinese shipyards. Those boats are being launched now. Marseille-based CMA CGM SA, for example, has placed orders for 80 ships, at a total cost of roughly $1 billion, to complement the some 400 it already runs. Geneva-based Mediterranean Shipping Company SA is scheduled to receive 57 ships, adding to its 427.

Maersk received 15 vessels in the first half and has 48 ships on order for delivery by 2012. "Given the present market conditions we're quite pleased that we don't have the largest order book in the industry," says spokesman Michael Christian Storgaard.

Maersk officials decline to disclose their plans for the new ships, but, if demand collapses, there are few options, says Dirk Visser, an analyst with Dynamar BV, a consulting firm based in Alkmaar, the Netherlands. "The best option is to convert the ship to a tanker or a cruise ship, then sell it at a loss," he says.

Increases in benchmark London interbank offered rates may boost homeowner defaults on resetting adjustable-rate mortgages, contributing to a "vicious cycle" in the credit crunch, according to Citigroup Inc.

The deepening of the credit crisis that started last year amid record defaults on subprime mortgages, contributing to $593 billion in writedowns and losses at banks worldwide, may end up causing more borrowers to fail to make their monthly payments. Libor rates, which track how much banks charge each other for loans, help set the cost of everything from credit cards to corporate loans.

"America's homeowners are going to get uncomfortably familiar with 'LIBOR' starting next month," the New York-based Citigroup analysts wrote.

Libor rates have soared since the bankruptcy of Lehman Brothers Holdings Inc. last month as financial companies hoard cash. The average subprime borrower facing an adjustable payment for the first time next month would face a monthly payment increase of about 18 percent based on Libor rates as of Sept. 30, rather than the 10 percent that would have occurred based on the rates on Sept. 15, the analysts wrote. The payment would be $1,951, instead of $1,807, they said. Fannie Mae and Freddie Mac loans would be boosted to $1,021 on average, instead of $904.

Their report didn't quantify the effect of higher Libor rates on any of the $361 billion of mortgages underlying bonds whose rates have already begun tracking benchmarks, changing monthly, semi-annually or annually. The report also didn't address whether higher potential "payment shock" may lead to increased efforts to rework mortgages by loan servicers, even though mortgage modifications are rising amid record foreclosures.

The seizure in global credit markets, sparked by the U.S. housing downturn, has been deepening on speculation central bank attempts to revive lending between financial institutions won't work, resulting in more failures. The Libor rate for overnight loans in dollars between banks rose 1.57 percentage point today to 3.94 percent, the British Bankers' Association said.

About 121,000 mortgages will reset for the first time next month, according to the Citigroup report, which looked at only securitized mortgages. About 1.8 million loans have already begun adjusting based on benchmark rates, the report said, while 3.7 million face resets scheduled for after next month.

"Almost all" subprime and Alt-A ARMs with a few years of fixed rates, about 60 percent of those prime-jumbo mortgages and about 75 percent of such loans in Fannie Mae, Freddie Mac and Ginnie Mae bonds are linked to Libor, the report said. The loans most often are pegged to six-month Libor.

Subprime loans are given to borrowers with poor credit or high debt. Alt-A loans were made to borrowers who wanted atypical terms such as proof-of-income waivers, delayed principal repayment or investment-property collateral, without sufficient compensating attributes. Prime-jumbo loans are made to the best borrowers seeking loans larger than Fannie and Freddie can finance. Fannie and Freddie are government-chartered mortgage-finance companies; Ginnie Mae is a federal agency.

The $700 billion bailout of Wall Street's subprime-tainted securities harkens back to the real- estate bets that sparked the savings and loan crisis in the 1980s. The geography's the same, too. Then, as now, the government created a taxpayer-funded enterprise to absorb the fallout from bad real-estate investments. A Bloomberg map of the hardest-hit areas shows that, with the exception of Nevada, regions with the highest foreclosure rates also had the most savings-and-loan failures, according to the Federal Deposit Insurance Corp.

The overlap shows that the aggressive lending and speculation that ignited the savings-and-loan meltdown persisted, at least in those areas, according to Paul E. Johnson, who was mayor of Phoenix from 1990 to 1994. "From where I sit, the areas that were hit by the S&L crisis and those struggling with subprime look pretty much the same," said Johnson, now president of Southwest Next Capital Management, a real estate investment fund based in Arizona.

Texas, where failed thrifts in the Dallas and Houston areas had assets of more than $45 billion in the 1980s and 1990s, has largely sidestepped the subprime crisis by learning a lesson from the S&L scandal and ratcheting up regulation. "We had no regulation of mortgage brokers before 1990 and now we have some of the most robust requirements in the country," said Doug Foster, commissioner of the Texas Department of Savings and Mortgage Lending in Austin.

Texas is one of 32 states that require criminal background checks for mortgage brokers and one of 12 states that administer tests that prospective brokers must pass, Foster said. The state has a 42 percent failure rate on that test, he said. Texas also requires 90 hours of training for new brokers and 15 hours of continuing education every two years. Only Wisconsin mandates more, he said.

Granted, home prices in Texas didn't rise as high as those in California, Arizona and Florida, according to the S&P/Case- Shiller Home Price Index. Los Angeles, Phoenix and Miami home prices doubled from 2002 to 2006 and have slipped by about one-third since, according to the S&P Case-Shiller Home Price Index. Home prices in Dallas rose 12 percent from 2003 to 2007 and have dropped 3.2 percent since then, according to the Case-Shiller index.

"Deterioration of property values in other states is the result of the run-up," Foster said. "We didn't have the run- up."California, by contrast, was hit hard by both financial meltdowns. Failed thrifts based in the regions of Santa Barbara, Ventura, Los Angeles, Orange County, San Diego and Stockton had combined assets of more than $95 billion in the 1980s and 1990s.

Now, the state is home to all five of the top metropolitan areas for foreclosures, according to RealtyTrac Inc., a real estate database in Irvine, California. California, Arizona and Florida rank second, third and fourth by percentage of households in the foreclosure process, behind Nevada, RealtyTrac said. Borrowers with subprime mortgages fell behind on their monthly payments at a rate more than four times that of prime borrowers, according to the Washington-based Mortgage Bankers Association. Subprime home loans went to people with bad or incomplete credit histories.

Some of the names from the era of Resolution Trust are familiar as well. Goldman Sachs Group Inc. and Morgan Stanley were among the underwriters of products created by the RTC, which recovered almost $400 billion in assets from about 750 failed savings and loans. They may be among the biggest beneficiaries of the new bailout plan as sellers of devalued assets, according to a Sept. 21 report by Bank of America Corp.

Overnight Index Swaps (OIS) are not exactly a topic that comes up a lot in dinner-party conversation. In fact, it is probably not a term that comes up in a lot of conversations about the financial markets. However, it is an important concept to understand because the OIS plays a vital roll in a market indicator that many economists and analysts watch every day to determine the health of the credit markets — the LIBOR OIS spread.

Overnight Index Swaps are instruments that allow financial institutions to swap the interest rates they are paying without having to refinance or change the terms of the loans they have taken from other financial institutions. Typically, when two financial institutions create an overnight index swap, one of the institutions is swapping an overnight interest rate and the other institution is swapping a fixed short term interest rate. This may sound a bit strange, but here is how it works.

Imagine Institution #1 has a $10 million loan that it is paying interest on, and the interest is calculated based on the overnight rate. Institution #2, on the other hand, has a $10 million loan that it is paying interest on, but the interest on this loan is based on a fixed, short term rate of 2 percent. As it turns out, institution #1 would much rather be paying a fixed interest rate on its loan, and institution #2 would much rather be paying a variable interest rate — based on the overnight rate on its loan — but neither institution wants to go out and get a new loan and they can't renegotiate the terms of their current loans. In this case, these two institutions could create an overnight index swap with each other.

To set up the swap, both institutions would agree to continue servicing their loans, but at the end of a specified time period — one month, three months and so on — whoever ends up paying less interest will make up the difference to the other institution. For example, if institution #1 ends up paying an average interest rate of 1.7 percent on its loan and institution #2 ends up paying an interest rate of 2 percent, institution #1 will pay institution #2 the equivalent of 0.3 percent (2.0 - 1.7 = 0.3) because, according to their agreement, they swapped interest rates. Of course, if institution #1 ends up paying an average interest rate of 2.2 percent on its loan and institution #2 ends up paying an interest rate of 2 percent, institution #2 will pay institution #1 the equivalent of 0.2 percent (2.2 - 2.0 = 0.2) because, according to their agreement, they swapped interest rates.

The overnight index swap market is quite large, and the movements in this market can provide a lot of information for economists and analysts who are trying to understand what is happening in the global financial markets. One of the key pieces of information analysts watch is the interest rate the institutions that have loans with variable interest rates are paying.

The question is, how do you determine what rate to use when each institution is paying a slightly different rate based on what time of day they have to determine their payment. You see, the overnight rate in constantly changing, and you will pay a different interest rate at 6:00 a.m. than you will pay at 11:00 a.m. To resolve this issue, an overnight index swap rate is calculated each day. This rate is based on the average interest rate institutions with loans based on the overnight rate have paid for that day.

By itself, the overnight index swap rate doesn't tell us much — other than what the overnight rate is. However, when you combine the overnight index swap rate with another indicator, like LIBOR, and create a spread like the LIBOR OIS spread, you can get a glimpse into the health of the global credit markets.

35 comments:

"My thoughts are with Iceland. Waking up to see your neighbors having gambled away your entire nation, that must be hard."

At least they won't go cold. I was there in 1979 for a week, trying to buy some casein contracts from dairies. I had been a plumber in an earlier incarnation (as I am in this one), and was impressed with their central heating plants which basically involved driving a large metal pipe into the ground and collecting the steam.

Martenson is quite correct saying that cheap energy is at the heart of everything. Joule slaves. Yet it is deliciously ironic that the only country in the world which has almost unlimited supplies of essentially free (geothermal) energy is the first to go bankrupt.

BTW Ilargi, do you know whether that casino toilet paper that the banks are holding is (what car dealers would term) pre-owned?

You mentioned that AE has saved a lot of people's money so far, and that's why there's a tip jar. Too true, but!

I just want to make the point (more to everyone else than to you) that there are more reasons for the tip jar. Personally, I wasn't about to take out a mortgage on what I always saw as overpriced houses anyway, but you and Stoneleigh have taught me (and others, I'm sure) more in the span of a couple years than any university course likely would have.

The radio program "This American Life" is back with another worthwhile podcast titled Another Frightening Show About the Economy". This time they do a good job explaining what the commercial paper market is, and why we should care about the fact that it has been frozen for weeks. They veer off into MSM-land at the end, however, in concluding that the Paulson bailout was painful, but probably the right thing to do. Bad doggie!

Their earlier podcast on the economy, The Giant Pool of Money was also very illuminating, for those that missed it the first time around. Also, NPR hosts a podcast called Planet Money hosted by these same guys. I listened to my first episode this morning on the bicycle ride to work, and it sounded well-researched on the importance of watching LIBOR and the TED spreads, brought down to layman's language.

Interesting times, indeed.

Rototillerman, who is waiting for Schwab to cut the check on my 401k loan to pay off the house... c'mon Schwab, get with it!

Royal Bank releases its economic analysis today and, according to the Star, "Canada's economy firm", while the FP and G&M say "RBC trims economic outlook". Of course, the truth is that the bank is still seeing pies in the sky, but the desperate optimism by both banks and amplified by the papers is tickling my dark humour.

When will we start seeing the next round of banks and financial firms fail like a few weeks back? It seems with the ban of naked short selling and injection of $630B into the financial system, they are still gasping for breath. Are there any more Lehmans or WaMu's left or is everything too self cannabilized at this point?

Ilargi:"I still can’t understand how anyone at all, after more than two seconds of reflection, could believe that a problem caused by too cheap credit at too low rates could be solved by lowering rates for more cheap credit. I just don’t get the reasoning."

:-) I sympathize, I do. I'm in the same place, frequently in my own field. How can they not get it??

The answer of course- as I know you already know- is that what is going on is not, in fact, a logical process. They believe; wholeheartedly, only because they want to, or must.

My own modified aphorism, for these situations: "Logic is the opiate of the educated."

Ilargi:"I still can’t understand how anyone at all, after more than two seconds of reflection, could believe that a problem caused by too cheap credit at too low rates could be solved by lowering rates for more cheap credit. I just don’t get the reasoning."

Doesn't it follow that the banks need a larger spread in order to return to profitability? Also, the last thing that cash strapped, fully debt enslaved consumers need is interest rates to rocket up. So you can't go there. At this point they don't need to ratchet up rates in order to get people to cut back on spending - that's already been taken care of. What would raising the rates really achieve? At this point I think that foreign capital is heading home to weather the storm. It's not just USA financial firms going poof during the "weekend huddle".

Democracy Now had an interesting interview (well one not so good with a guy who thought that the USA bailout wasn't the best thing to do - but it should be done and then details sorted out) with someone who pointed out how the failure of the banks was predicted in the 80's and again in the 90's. I'm sure that many think that this is just a speed bump; if we can just get over this little hurdle, the all of that toilet paper will be transformed into something wonderful (compost?) and life can go on.I'm watching with interest what's happening to my physical gold, vs precious metal fund, vs energy stocks vs safe (?) bonds and term deposits. The precious metal fund is off 50%, Sprott Energy fund down around 30%, gold holding it's own and the bonds returning a boring 5%.

Discontinuation,confusion,terror, our whole existence is now being flooded from every direction by wave after wave of news that,if examined closely has the trimmings...the slight tiny faintest whiff of panic.People are coming out of the fog of their normal life,and sitting up and paying attention to the show.

Most of the players keep a lid on it,but,every so often the "deer in the headlight" look pops on the face of even the local news models

I think we will have one event, soon, that will result in a "pop" that signifies a "we're not in Kansas anymore,Toto" realization by the general public.That is when the pillaging of the stores ect.will start,and life will get interesting.Or,things will bump along until the election...and with the probability of some serious trouble should it look like it was thrown due to fraud....

Make no mistake about it, Wall Street championed the cause of impoverishing our workforce. Over the last 30 years or so, slowly rising, or even stagnating incomes, was considered a positive indicator. One consequence of the housing bubble is that the price of housing is going to have to drop to the point that families earning a median income can afford to buy median priced housing. The fly in the ointment is the fact that our elected officials over the last three decades have enacted policies that were and are intended to put downward pressure on wages. This was not just a happy accident. It was intentional. The already wealthy were to be ever further enriched and then invest their ill gotten booty wisely. Theoretically, anyway. In reality they leveraged their investment stash and used this mad money to create and profit from asset bubbles. This was not the productive investment our elected officials envisioned. Now, the downside of our no longer stagnating, but now falling incomes, is going to come back at us. Worker income is a dog nipping at our heels. Median housing prices have a long way to fall before they realign with our falling median incomes. Who the hell do they think is supposed to buy all these foreclosed properties? Our economic recovery will not begin before housing hits bottom and begins rising. We have a long downward spiral to endure before that happens.

Politically, we've been misdirected. We've allowed ourselves to be distracted by this moronic culture war, and our pockets have been picked in the process.

team10tim, an html tag a link requires always the http or https to work as expected, ie:

<a href="http://google.com/">google</a>

The www is and pretty much always has been purely cosmetic, with no functional use in almost all cases. A convention, and an easy way to let some software know it's a link.

ilargi, outstanding columns and work in this week, I wish I had time to read the stuff happening but I'm too busy, but your comments each day have been very strong. Keep up the good work, I know just about now a friend's mom I talked into selling off her stocks is probably feeling a bit of gratitude...

What will happen if Iceland defaults on its loan from Russia? Will Russia end up buying the whole country like England did with Scotland in 1707?

Scotland had bankrupted itself with an attempt to build a colony in Panama, the Darien Scheme

The 1707 Acts of Union, Article 14, granted £398,085 10s sterling to Scotland to offset future liability towards the English national debt. In essence, it was also used as a means of compensation for investors in the Darien Scheme.

I make that about £80 million in today's money. Cheap for a 'country merger', but then money was 'real money' in those days.

I think Iceland will find that loans from Russia come with strings attached, but then so did structural adjustment loans from the American-backed IMF/World Bank. Great powers usually extract a 'pound of flesh' from those they help.

We're certainly heading into the liquidity trap. Hoarding greatly reduces the velocity of money, which exacerbates the spiral of debt default and therefore deflation.

From the point of view of the individual or institution doing the hoarding it makes perfect sense to hold on tightly to something scarce and valuable, but doing so aggravates the problem faced by the system as a whole. Unfortunately, putting the interests of the system first will merely ensure personal disaster, as only a small minority will be able to cash out. It's a 'prisoner's dilemma' situation, as game theorists would say.

We suggest that you look after your family and your community, partly because if you don't, then no one else will, and partly because there's nothing else you can do anyway. You can't save the system in it's current form, so save what you can at a local level. Be prepared for a large drop in material living standards, but also for the rediscovery of what truly makes us human.

"There is such a thing as being too late ... Life often leaves us standing bare, naked, and dejected with lost opportunity. ... Over the bleached bones of numerous civilizations are written the pathetic words: 'Too late'." - MARTIN LUTHER KING, JR.

Well said. Although I hold out a less doomerish outlook than you and Ilargie there's not much to argue with there. Thats good advice and a good outlook no mater how this thing turns out.

By the way: You and Ilargie make quite a team - sort af a fire and ice kind of thing. Oopps I guess I've seen Spinal Tap too many times - any one for luke warm water?

On a different topic:

In the blogosphere there is a tendency to see a conspiracy behind every tree. (sort of like some see terrorists) Over at the oil drum I found a couple of quotes that gave me a smile and hold a lot of truth.1) "Never ascribe to malice, that which can be explained by incompetence." 2) the corollary "Any sufficiently advanced stupidity is indistinguishable from malice."

Thanks for all the analysis and information. I have been trying to work through this whole situation to figure out what is going on and how best to get out of this. Now, I think I have finally figured out how to best explain what I think is going on. I realized this because I have been seeing medical analogies in many places such as cardiac arrest or cancer. I finally realized that I think the diagnosis is totally different, far less exotic, and more obvious than what's currently discussed.

My diagnosis for this crisis is that I think capitalism is predisposed to developing diabetes, or a credit metabolic disorder that if left unchecked can have devastating consequences including a liquidity induced diabetic coma of the credit market. I think the credit market is truly comatose and now I am afraid that what is supposed to be the "cure" will actually lead to complete organ failure.

I do not know what the root cause of capitalism's diabetes is but I think the first Great Depression was caused by Type I economic diabetes. I think our current situation is caused by Type II economic diabetes. I think the regulatory structure put in place after the Great Depression was supposed to manage this condition, but that we have over time come to believe that we were cured.

So, now rather than improve the effectiveness of the treatment or search for a cure, we stopped taking our meds and reverted to prior bad habits to such an extent that we have a very serious case of Type II diabetes. This diabetes is caused by our inability to properly metabolize large amounts of credit due to liquidity resistance.

If my diagnosis is correct, than the current proposed course of action can kill us off rather than lead us back to health. Constantly adding liquidity is only making the coma worse. What I find most disturbing is the plan to backstop the commercial paper market and the municipal bond market because I think this is an indication that our economic blood chemistry is so unstable that we are now causing organ failure. If we go too much further, we will not be able to recover at all.

Type II diabetes in humans is a treatable and manageable disease but when left unchecked for too long can lead to such severe problems in humans that we are now seeing in our economy. The best course of treatment would be to stabilize our economic blood chemistry first by stopping the introduction of liquidity. Next, with Type II diabetes we have to change our eating habits permanently, i.e. we all have to stop ingesting credit in such high doses. This will lead to a massive economic slowdown that will be painful, but it is the only way to restore our economy to some kind of biochemical balance. Eventually, we will reach a new and very different credit metabolic level because once liquidity resistance is built up, our economic body will never be able to fully reverse the process.

Going forward, we must all admit that our economy is diabetic, that this is a chronic condition that will never be cured and so we have to work together to ensure that we know how to properly monitor our credit-sugar levels so that we can keep our economic blood chemistry stable.

I guess I'm saying that this is a bad situation, but once properly diagnosed, it can be treated and dealt with effectively. The consequences of our inability to diagnose the problem means that our economy has been permanently and unalterably changed. But, I am more afraid of an incorrect diagnosis resulting in our using chemotherapy or shock paddles to restart our diseased body. The treatment must address the disease or else we will have an even bigger disaster.

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